Top of the Morning: FOMC reflections & US economy health-check
The desk believes the recent hawkish rate hike from the FOMC signals a commitment to combating inflation more aggressively, setting the stage for potential further increases this year. Per the full note from UBS, economist Andrew Dubinsky highlighted a significant change in tone from the Federal Reserve, with virtually unanimous support for the rate hike and minimal dissent. This suggests the Fed is keen to restore inflation to target levels, indicating that market participants should prepare for heightened volatility in the USD as traders recalibrate expectations around future rate increases.
What the desk is arguing
The desk interprets the recent FOMC meeting as a pivotal moment, establishing a clear path towards additional rate hikes in the near future. According to Dubinsky, the Fed's decision to define their stance as 'removing a dose of accommodation' demonstrates their intent to act decisively on inflation, with only two members forecasting a 'one and done' scenario for rate hikes. This hawkish pivot could very well shape trading strategies in the FX market for USD pairs, particularly against currencies like the EUR and JPY.
The current environment reflects a shift in market sentiment; with eight out of eighteen policymakers anticipating at least two more rate hikes this year, traders may need to align their strategies accordingly. The removal of previously held 'transitory' explanations for inflation further underscores the Fed's resolve, marking a significant commitment to curbing inflationary pressures more rigorously.
Where it sits in our coverage
Our consensus target sits at 1.075 for the EUR/USD pair, within a range of 1.04 to 1.12. Specific targets from peers include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This perspective aligns closely with jpmorgan, indicating a relatively optimistic view on the USD's strength in relation to the EUR. It diverges from bofa, which remains more cautious about the USD's ability to sustain strength in the prevailing environment.
How other firms see it
Firms like jpmorgan and citi appear aligned with our hawkish outlook, suggesting robust support for continued USD strength. Conversely, bofa offers a more bearish outlook, anticipating USD weakness against major currencies.
The EUR/USD trajectory is notably tied to any shifts in ECB policy, as their response to the Fed’s actions will be crucial. Traders should also monitor the USD/JPY pair, as it may reflect the competitive dynamics arising from divergent monetary policies between the Fed and the BoJ.
01FOMC's recent hike signals potential for further increases this year.
02Statements indicate strong consensus among FOMC members against easing.
03Market volatility in USD pairs expected as expectations are recalibrated.
04Focus on effects of Fed policy on related FX pairs.
Market implications
With the Fed indicating strong support for at least two more rate hikes this year, traders should watch the EUR/USD for any potential push towards the 1.05 level. Adjustments in positioning in response to the Fed's policy shifts could create volatility in USD crosses, particularly if market expectations shift rapidly.
Risks to this view
A significant catalyst for reversing this bullish stance would be any unexpected dovish comments from Fed officials or worse than anticipated economic data that might prompt a reevaluation of the rate path. Additionally, factors such as geopolitical instability or a fresh wave of COVID-19 could further complicate the economic outlook.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today's conversation, we will spend some time reflecting on this week's FOMC meeting outcome.
We'll talk a bit about an outlook for monetary policy, the health of the U.S. economy, and some takeaways as well from Chairman Kevin Warsh's press conference. I do have sitting across from me here at the 1285 Podcast Studio in New York, a U.S. economist from the UBS Chief Investment Office within UBS FSI, Andrew Dubinsky. Andrew, thank you for joining us.
I know you've been running around a lot, a lot of calls, a lot of commentaries, but thank you for carving out some time to be on Top of the Morning today with our listeners and clients. Great to have you. As a starting point, Andrew, maybe just general reflections, takeaways from the statement itself and what you picked up on during the press conference yesterday with Chairman Kevin Warsh.
Yeah, I think the bottom line is this was a hawkish hike, and this really sets up, there's a low bar for additional hikes this year. And we got this kind of, this hawkish message in the statement, we got it in the press conference, we got it in the projections. And the statement was unanimous, no dovish dissents, which was a modest surprise.
And the statement took out some of the explanations for why inflation had been high. You could call them transitory explanations if you want to use a dirty word, but those went out. And it was clear that this adjustment was made to get inflation to have a faster return to target.
And I think that Warsh explained that in the press conference and reused the words, removing a dose of accommodation about three times. So it's clear that there's a lot of support for this hike and at least for one more. We look at those projections, only two participants were suggesting to have one and done.
So a lot of support for at least two and not quite half, but about eight out of 18 supporting even a third hike. So the risks are skewed to more as opposed to less hikes. And I think it was clear there's a lot of factors that went behind the decision.
The chair explained that. It's a strong growth and job growth trends in the intermediate period. The inflation trend is just not improving fast enough and the August data was a disappointment since it surprised the upside.
He de-emphasized one data point. So it's really clear that the trends need to get better and the bottlenecks and they're on conflict have worsened. So you can see this through oil prices or you can see it through business surveys where firms are saying it's taking longer to get their delivery.
So it was a meeting with expectations of a hike, but it still surprised the upside with this hawkishness. You make a valid point about the inflation concerns. We'll dive a bit deeper into the inflationary environment, the health of the labor market a bit later in the conversation, Andrew, though, I do want to get your thoughts on an outlook for monetary policy through CIO's lens.
Where do we go from here? So our base case is to have one more hike, so a total cycle of adjustment of two with risks to more, maybe one more, and that with the idea that we'd have at least one more hike this year. And then the Fed would stay on hold as it observes the inflation slowly but steadily improving the target.
So that's our expectation is that we're going to get a lot more disinflation this year as tariffs roll out of the year-over-year numbers. And then as we get to the beginning or around March of next year, we start to see a lot of the energy effects roll out of year-over-year numbers. So the case for a longer hiking cycle we think will continue to get weaker over time.
When you look at policy rule prescriptions, Taylor rules, and you plug in the relatively hawkish projections from the Fed participants, you get prescriptions for a policy rate of around in the low, mid-4% range for 2027, so certainly below market pricing and nothing really suggestive that we need to go close to 5% or close to even going to a total cycle for hikes would be harder to rationalize without a really strong view of underlying neutral rates, which is – it's hard to have a high conviction view on that. So I think that's a harder case to make. So one more risk of two more hikes on hold for a while and then start to reverse them as we get to the end of next year.
Any thoughts on how the markets have been digesting this news and these developments out of the Fed? Any thoughts on the initial market response and what we've seen this morning? Yeah, the initial response I think directionally made a lot of sense.
You see two-year yields go up by around 13 basis points. Stocks went down a bit and you saw the dollar strengthen. So that's all consistent with a hawkish surprise.
You did see relatively little movement on the 30-year bond, which I interpreted as a positive development related to just much clearer communication. People, investors, Fed watchers, we've been looking for a much clearer idea of what the chair's reaction function is and he started to give us a lot more signposts of the things he's watching. He's giving us nowcasts from the Fed staff.
These are all things that chairs in the past typically would do, but he just hadn't really been providing them so far. So now we just have a better template of just what he's looking at and that maybe his approach isn't so different than prior chairs. And today's move, yeah, definitely interesting.
Maybe it's a version of buy the rumor, sell the news in the sense that maybe the amount of hawkishness that was priced into the market yesterday did seem excessive. So maybe some of that is coming out. And we do see as we're recording the S&P 500 at around 9.45 a.m.
Eastern is up a percent. So we'll continue to monitor the markets as we make our way through today's session. Just to close out today, Andrew, on the overall health of the U.S. economy, you mentioned the inflation data a bit earlier.
Would love to hear your thoughts further on that. Health of the labor markets and given this rate hike, you know, impact of credit card rates, mortgage rates, all of those considerations. Yeah.
So we'll start with like what's happening with activity trends, which was certainly a factor that Boris brought up. First half was strong, especially if you look at the private demand side of the economy. Consumption and investment growing around 3% annually.
So definitely pretty strong rate. And then as we get into the second half, it looks like a lot of that momentum has carried over and GDP tracking for the third quarter is around 3%. And that's definitely I think stronger than most expectations at least a few months ago and definitely stronger than what I was expecting given that new income growth has been on the softer side.
Now on the momentum within the labor market and important for income growth had picked up in August. And so there's no way to describe the last jobs report as just pretty strong all around. And so it definitely should help these consumption trends going forward.
And obviously the stock market appreciation has been a tailwind that should continue along with AI CapEx. And then switching to the inflation side, we think the last month's upward surprise in inflation was aberration. And we'll just continue to get more prints closer to target on an annualized basis.
Inflation effects and tariffs have largely rolled out. Shelter inflation looks pretty benign, even lower than where it was pre-COVID. And energy prices are going the wrong way, but they've been at an elevated level for a while.
So there's not a lot of incremental upside from there. In terms of other things we're going to be watching, obviously the signposts are growth and inflation trends. And in terms of just how rates moves will affect the real economy, obviously in the very short run, like you mentioned, passes through to credit cards and home equity loans pretty quickly.
There's about $2 trillion of household loans, I would say, roughly tied to floating rate instruments. So that 25 basis point increase will have, I would say, a modest effect on free cash flow. But more importantly is just what's happening to longer term rates, and there's other factors driving that.
And Leslie Falcone has talked about that. And those are at elevated levels, and it's not going to be – obviously by design, at least from a policy perspective, that should put some downward pressure on interest rates since that activity and housing activities kind of continues to look pretty subdued for the medium term. But there's other factors in that long end move, and it's possible that with additional clarity from the chair, we've kind of seen at least one contributor to our lower – our expectation that yields move lower from here.
Well, Andrew, thank you very much for dropping by Top of the Morning today to provide some thoughts, reflections on this week's FOMC meeting, implications of that outcome to U.S. economic activity, and for shedding some perspective on the market response as well. Look forward to continuing our conversations. I know we have other Fed meetings ahead of us, so we'll continue the conversation here on Top of the Morning.
Yeah, I look forward to that. Thanks, everybody. Thank you for tuning in.
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